H.R. 3915: a FRANK Discussion

I'm not going to rewrite the HR 3915 bibles that have already been written. This article will simply collate the most valuable information available on the bill at this time and of course you will get my opinion after I give you the facts. But PLEASE, before you share your opinion with anyone verbally or in writing, please do yourself the courtesy of making sure you understand the bill and its implications. Some housekeeping:

• HR 3915 just passed committee in the house and is now moving to a vote. What is HR 3915? If you don't know, then please read it here.
  
• If you still want to have an opinion about it, but can't be troubled to wade through the bureaucratic verbosity of a full house bill, here is a synopsis.
  
• And if you haven't heard of the proposed updates to it and you are still planning on having an opinion, please check this out (this is how the bill passed committee).
  
• Section by section summary of changes.

Finally, if you are not intimately familiar with the many factors of the "mortgage meltdown," I suggest my article as a primmer for the ensuing discussion. The following discussion on HR 3915 will be hard to follow unless you understand the background.

Now that's out of the way, how about a FRANK discussion (pun intended)? I'm really not going to get into the particulars of the bill as far as examining each aspect and discussing pros and cons. That has been done and you can also do it for yourself. There are a couple nice blogs out there where people have broken down and discussed several of the aspects. Here's an example.

I'm not interested in debating with those of you with obviously radical opinions. The whole "mortgage meltdown" that caused this knee-jerk reaction is an infinitely "gray area." Those of you who respond to this issue with black and white zealotry are no doubt envied by proctologists for your amazing view of your lower GI tract. Let's take a nice walk down common sense lane and discuss the shades that comprise this gray area.

HOW DID WE GET HERE?

People have been burned. There's no doubt about it. Regardless of who is at fault, people, wholesale lenders, mortgage brokers, realtors, investors, banks, traders-many entities have lost money, lost their incomes, lost their assets, and lost their homes as a result of the housing sector mess. It's an unprecedented catastrophe that has a lot of people angry and feeling wronged. When people feel wronged, they tend to try to assign blame to another entity to mitigate their feelings of suffering. Further warm and fuzzies for these folks sometimes come in the form of lashing out against those they are blaming. On my other article "The Current State of the Mortgage Market," I get questions all the time about what percentage of the blame would I assign to a particular entity. I try to be as cordial as I can in responding to those questions and I will be cordial here: it's not that simple.

As far as addressing all the diverse items contained in HR 3915, The National Association of Mortgage Brokers (NAMB) has done a good job. Their testimony can be found here. Keep in mind there have been changes to the bill already in response to this testimony, which is good. But let me take a brief moment to address some of the more salient points, just so you know where I stand. Both the NAMB and all ethical, hardworking mortgage originators I know agree with the following points (not all of these are worded this way in the bill):

1. I would be happy to support the implementation and enforcement of better minimum standards for ALL loan originators, this includes FDIC insured bank loan officers (the original bill greatly relieves this obligation for FDIC banks).
2. I would support any reasonable anti-predatory lending laws.
3. I would be happy to have one universal method of disclosing fees and income on a loan for ALL entities that originate a mortgage. (under the current bill, mortgage brokers and FDIC banks fall under different requirements).
4. I don't think that a mortgage originator's net worth has any bearing whatsoever on how ethically and accurately they conduct their business. In fact, I know of people with a lot more money than me that got that money by overcharging clients! As it stands the bill calls for a large net worth requirement, which has since been reduced in revisions.
5. As an originator, I absolutely, positively, must be allowed to use the feature of YSP in order to give my clients the most competitive quotes.
6. There is no one you will encounter that supports truth in advertising more than I do. I think that organizations advertising low teaser, or negative amortization rates without warning the consumer about the implications, should be taken behind the barn and shot.

It looks like most of these points will be addressed one way or another in the revisions to the bill. However, it is still unclear if FDIC originators will be held to the same standard as non-FDIC originators. Furthermore, there is still the issue of YSP not being paid on non-prime loans and the extremely crucial point that "non-prime" loans are not clearly defined in the bill.

BUT LET'S FORGET ALL THAT FOR A FEW MOMENTS

Follow me for a moment on a brief analogy. Drugs are a big problem in this country right? We lock up drug dealers, we lock up people who use drugs, and we lock up people that traffic drugs, right? No matter how much we try to punish and regulate drugs, people still use them. Even though people know that drugs are bad for their health, they continue to pursue them and create the demand for them. But if either the supply or the demand were to go away, there would be no drug problem. What if, instead of trying combat drugs on all fronts, the US Government just decided to punish people who used drugs? Traffickers, growers, and distributors could all do as they please, and they could even make their drugs available to the end user without penalty. Would this make any sense to you? Of course not.

Now, what if the grower's costs became so high that it was no longer cost effective to produce drugs? What if absolutely no one were producing any drugs? Would drug laws even be necessary then?

The drug of choice in the US for the last 5 years has been bad mortgage loans. It takes a whole supply chain for the end user to end up with a foreclosed house due to a bad loan. A consumer has to want the loan. A loan officer has to originate that loan. A bank or intermediary has to provide the funds for that loan. An appraiser has to generate a value for the security of that loan. Title companies have to insure against liens on that loan. A bank has to offer to underwrite the risk of that loan. And finally, the wall street investor has to create a demand for the Mortgage-Backed-Security that the loan will ultimately become.

The moral of the story is that there are multiple potential causes in any given mortgage scenario that can lead to the distressed mortgage and real estate market. That's why I scoff when someone blames just one aspect for the whole crisis. For example, "this whole meltdown is due to mortgage fraud," or "we wouldn't be in trouble if the ratings agencies hadn't said mortgage backed securities on non-prime loans were a safe investment." No, my friends, in this case, it has taken the whole village. To bring the analogy to a close, I would wager several of my body parts that the "growers and distributors" of our evil mortgage drug have learned their lesson the hard way. The same drug will not be available in the future and it has NOTHING to do with legislation.

Does anyone on the house financial services committee understand the market forces of the "economic village" that raises bad mortgages? I turned on CNBC 3 weeks ago to hear a certain chairman passionately impugning prepayment penalties on mortgages. It went something like this (eyes opened blazing wide, spit flying, voice raised, in an earnest tone of disbelief):

"I can't believe it, but I hear tell that a mortgage lender will actually offer a higher rebate to an originator on a loan when there is a prepayment penalty! Also, I've heard that a mortgage lender will actually offer a proportionally higher rebate to an originator on a loan with a proportionally higher interest rate. That is preposterous!"

Is it, Barney? You can't believe that an investor would be willing to pay a higher price in order to ensure a minimum guaranteed ROI? Are you frickin' kidding me?!? Do I have to explain this?

Let me break this down for those of you with glassy eyes in the audience. These days, mortgage money comes mostly from investors. If you can believe it, investors look at mortgage-backed investments just like any other investments: they want to know how much it costs and how much they can get back. If it costs less, they expect less back, if it costs more, they expect more back. If a minimum return is guaranteed (cough cough, prepayment penalty), then they are willing to pay slightly more for the investment. This is all ECON 101 type stuff.

YSP, or yield spread premium, is a "premium" paid to an originator for making loan at a certain "spread" above the current "yield." Investors pay that premium because higher interest rates mean higher dollars collected over time. For the layperson, this simply means the higher the interest rate on a given mortgage, the higher the amount of money it generates for the mortgage value chain. This allows the broker to make a rebate when they originate the loan, which is paid to them by the bank that funds the loan. The bank in turn can earn an SRP or service release premium when they sell the loan. The ultimate investor that services the loan in turn earns greater interest over time. Part of the travesty of current and proposed legislation is that it has two separate standards for disclosing YSP and SRP, when in fact they are more than analogous.

The first draft of the bill proposed to completely do away with YSP! Newsflash: this is what allows mortgage brokers to be competitive and beat the pants off retail banks when it comes to quoting interest rates and fees! As a mortgage broker, I've NEVER, and I mean NEVER EVER, not been able to heartily beat a fee and rate quote from a retail FDIC bank. It's not even close. It's not even in the same ballpark. Whereas they are charging 6.75% on a 30 year fixed, I would be charging 6.125% with the same fees. Whereas some huge FDIC retail mortgage operations have a required income of over 2% between origination and YSP on a loan, my required income as a broker is whatever it takes to keep the lights on, and that's a lot less than 2%. If a client wants a no closing cost loan, I can offer that for them by making my income on YSP. If a poor, but hard-working family can qualify for a mortgage but not for the down payment, I can get them their loan using YSP to pay for their closing costs. 3915 would severely limit or do away with that.

The fact is that there have been "bad actors" in the industry that have been misleading clients and overcharging them. Whether they are small brokers or loan officers for large banks, there are people out there that will do anything to make a dime. The drafters of 3915 want to combat these folks, and I support them in that, but they are going about it in the wrong way. They are not-to use the clich�-coming anywhere close to "nipping to problem in the bud." Lucky for them the problem is already correcting itself at the root level. Simply put, investors are no longer buying the securities that made the bad loans available. That's it! The loans that are causing the mortgage melt-down don't even exist any more because they have proven themselves to be a detrimental investment for all parties involved. 3915 lashes out against a problem that has come and gone. Again, the roots are dead. The lesson has been learned. All that's required now is a little pruning to keep the growth healthy.

The pruning would be minimal but incredibly effective. Consumers need to be educated on how mortgage loans work. They need to understand what they are signing and what the implications are. They need to know whether or not there is a prepayment penalty. They need to know they can raise their interest rate and pay less fees, or lower their interest rate for a cost. The fact is that consumers should be EDUCATED on how the mortgage process works. The nature of the transaction should be DISCLOSED to them in a brutally simple and easy to understand manner. AND this disclosure should be universal for anyone who is originating a mortgage regardless of their net worth, and whether or not they work for a small mortgage brokerage or a large FDIC bank. All my clients know these things, and so do all the clients of other ethical mortgage brokers I know.

But of course, the government has to appear to be ruthlessly proactive in its approach to help the American public. The most alarming thing about it is that it falls into that dangerous category of legislation that appears to be a win-win because all it claims to do is PROTECT consumers. Psychologically, this tends to create mass lemming-ism and preclude ignorant constituents (and even congressmen/women) from reading the fine print. Any time a politician can dress something up in this manner, it will get an inordinate amount of support. Say for instance I want to save the whales. I would introduce a bill to "save the whales." Everyone would vote for it because who wouldn't want to save the whales? The only catch is that my bill saves the whales by feeding them humans! 3915 is not that black and white, and in fact, there are positive aspects of it as noted above, but it is not a panacea for the mortgage and housing convulsions our country has been experiencing.

I hope I have been clear in saying that a majority of the problems 3915 is attempting to address have already been resolved by the beautiful action of market forces. The remaining pruning should be done in a more sober and step-by-step approach. The House must realize that no one area of the market is responsible for our current turmoil. In fact, I will assert that consumers are afforded some of their very best deals by being able to work with smaller, local, independent mortgage brokers as opposed to FDIC banks. If you cripple the mortgage broker, then a semi-monopolistic pricing policy will emerge in the FDIC banking sector. Consumers will feel like they've been protected yet they will be paying 0.5% higher interest rates for their loans, and contributing to a sense of complacency among FDIC banks.

Our company's President, Tom Evans, has been using YSP for over a decade to continually amaze his clients with his competitive rates, offering choice to an educated consumer, and excellent customer service. His past customers would line up around the block in his support. Other people like him are out there, and they are crucial to the healthy competition that keeps rates low and customer satisfaction high. Bottom line: to a certain extent, 3915 is not selective against who it harms. The good guys get hurt just as much as the bad guys. You wouldn't destroy a rose just because some of the petals need pruning.

Again, the reasonable solution here is to make sure that mortgage terms are disclosed properly. From there, it's a free market. If Big Bank A is offering you 6.75% with $5000 in closing costs and I can do 6.75% with no closing costs, do you, as a consumer, care if my income is paid by the lender? Bad actors should be removed from the industry whenever possible, true, but the ultimate "drawbridge" is the fact that investors are no longer offering certain mortgage products combined with the potent medicine of consumer knowledge. Once we can ensure that ALL mortgage originators are on an even playing field and that consumers all get the exact same type of disclosure from any mortgage originator, then the problem is truly solved. The consumer then knows the rules of the game and can do exactly what they are supposed to in a free market: make their own choices as to what's in their best interest.

I would urge you to take immediate action against this bill, however, it has undergone, and will probably undergo future revisions. Don't take that to mean that no action is required though. Keep yourself informed on the changes in the bill. Thousands of your own dollars in mortgage interest are at stake.

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